Index Investing an Even Worse Fate than Stock Picking?

By now everyone knows that stock picking doesn’t work – on average. That’s why hedge funds and the like are doing so poorly. Active investing is just about finished. In response the so-called smart money has headed into index funds and ETFs. That way you are supposed to be able to keep pace with the S&P or whatever index you care to choose.

Let’s figure this out. Now the aim is to hope to keep up with the indexes, not to beat them. That’s because academics and researchers have conclusively shown that you can’t beat them on the average. So everyone in Wall Street and beyond has taken fright and is now following this counsel of despair.

You don’t need innovators, imagination and real quants when you take this defensive view. What you need in accountants and actuaries. Is this the result of the bold swashbuckling investors being forced out by timid regulators and fund managers? Or is it something deeper, a retreat into only ever playing defense, an exercise and emotional support for the timid?

This new mindset heralds an epochal move in Wall Street. Don’t hire and use innovators; instead find and support bureaucrats and technocrats.

Once you move to this approach you can only ever do as good as the markets. You lose the striving types, the creators and the movers and shakers. You fall into the hands of the know-nothings and the do-nothings. Intellectual curiosity goes out of the window. Hasn’t the cure become worse than the disease?

There is a new way, namely behavioral finance-based approaches such as my company has pioneered. But the financial services companies and investment houses have now turned too timid to try these things out.

Kind of like genetic research in the old Soviet Union after Lysenko was anointed king of the geneticists where everyone genuflexed to the new doctrine, even though of course it was tragically wrong. As a result the Soviet Union fell behind everyone else in genetics until this very day. Is the same thing happening in the US? Just with economics this time?

The accepted investment thesis these days is based on traditional economics, even though we all know that it doesn’t mostly work. It doesn’t take into account irrationality and behavior. But the financial services world has turned too craven to want to experiment with these things. The powers-that-be of the investment world have decreed that anything but index investing is much too risky and everyone has obediently come along.

The move to IUA (Indexing Uber Alles) has frozen out all other approaches. It has shorn the investment industry of the very types we need to move to an investment approach that will decisively beat the old fundamental and technical approaches. It has reinforced reliance on a discipline that is now obsolete. And what we have gotten in return is an approach that promises us only that we won’t do any worse than anyone else. The flight to the golden mean. Is that what we really want?

Index investing has done far more damage than just permanently limiting our returns from investing. It has permanently changed the culture of financial services and investing such that it hires technocrats and bureaucrats rather than creators, innovators and shakers who can really move the needle, if not break it entirely. In maintaining safe returns we have given up the future.

About the author

Dr. E. Ted Prince is CEO and Founder of the Perth Leadership Institute, which has developed unique leadership assessments for financial leadership and business acumen. He is the author of The Three Financial Styles of Very Successful Leaders, published by McGraw Hill in 2005 and since published in China, India and Taiwan and Business Personality and Leadership Success: Using the Leadership Cockpit to Improve Your Career and Company Outcome published by Amazon Kindle in 2011. He has numerous publications in the area of leadership, management, human resources, business strategy and technology and is a frequent speaker at industry conferences. He has held the positions of Visiting Lecturer at the University of Florida and Visiting Professor at the Shanghai University of Finance and Economics.
Dr. Prince has been CEO of several companies in the technology area over a period of 20 years including Chairman and CEO of a public company for 6 years. He has also been on the boards of numerous other companies including several public companies.
Dr. Prince holds a BA First Class Honors degree in languages and political science from the University of New South Wales in Sydney, Australia, and MA and Ph.D., degrees in political science from Monash University in Melbourne, Australia.